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PETER COOPER: Welcome to the Real Vision daily briefing. It's Thursday, May 7th. I'm Peter Cooper. And we have Real Vision's managing editor, Ed Harrison and Roger Hirst standing by to give you their macro analysis.
But before we go to them let's go over the latest developments in the news today, I'm going to dive into what's going on in the eurozone and what its economic future will look like over the coming months. And then I'll hone in on Italy and where they're at now.
The European Commission released a forecast saying that the eurozone economy will contract by 7.7% this year due to the COVID-19 outbreak. As a result, inflation will slow to 0.2% this year, and the aggregate budget deficit will climb up to 8.5% of GDP as compared to 0.6% last year. The countries in the eurozone who face the most difficult path to recovery are Greece Spain, Portugal, and Italy.
Italy's GDP is forecasted to contract 9.5%, second behind Greece at 9.7%. Italy's budget deficit will reach 11.1% of GDP from 1.6% last year, and their debt will be at 158.9% of GDP this year.
As we know, Italy's battle with the coronavirus has been devastating, and their total confirmed deaths almost reach 30,000, the third highest globally. However, this wave of coronavirus in Italy has been winding down as their confirmed case counts show a defined downward trend. Having a sense of what stage they're at in combating the virus and the state of their economy, what happens next?
If it wasn't bad enough that Italy's debt was already headed towards extremely high levels this year, Italian debt experienced a sharp sell off on Tuesday after the ECB and a bond buying program was confronted in Germany's constitutional court. This court case will weaken the support that the ECB had decided to provide Italy through purchasing assets, totaling 120 billion euros through the end of 2020. In terms of labor markets, unemployment in Italy has actually dropped sharply in the last couple of months.
Italian unemployment has been notoriously high for a while, but in March the rate had dropped from 9.3% to 8.4% when most countries unemployment rose sharply. ISAT, Italy's National Institution of Statistics, also reported that this was due to a jump in inactive working age citizens as people had dropped out of the labor force altogether. They cited that 267,000 fewer people were looking for work during March. We'll need to wait a few more weeks to see if this pattern persists in April's data, although it is likely that it will as their lockdown has been the longest and most restrictive out of all European countries.
Before handing it over to Ed and Roger, I want to touch briefly on Norges Bank, Norway's central bank and their recent decision to cut rates. Norway's economy is expected to contract by 5.2%, and the size of this contraction is unlike anything that Norway has seen since World War II.
According to Oystein Olsen, governor of Norges Bank, data from Norway's labor and welfare agency shows that April unemployment in Norway was more than 15%. The Central Bank had cut interest rates down to zero from point .25%. And this is the third rate cut Norges Bank has done in less than two months.
For the time being, they will keep interest rates at zero and not fall into negative territory. However, this isn't fully ruled out. And with that, let's hear what Ed and Roger have on their minds. Ed?
ED HARRISON: Thanks for that, Peter. It is Thursday, the 7th of May. I am here in the DC area. I am talking to our managing editor over in the UK. Near Ipswich is what I understand, Roger. Is that right?
ROGER HIRST: That's correct, yeah. [INAUDIBLE] near Ipswich.
ED HARRISON: Excellent. So Roger Hirst is the name. Roger, let me read something to you, because I actually I sent this to you earlier today. But I think this is important, given the conversation you were having about monetary policy with Ash yesterday.
This is from Axios. They quote from Bank of America Global Research. The monetary policy response to COVID-19 has been massive. What's happening? Led by the Fed, which has added $25 trillion to its balance sheet in less than two months, all the world's major central banks have taken extreme policy action.
The Bank of Japan has doubled its ETF purchase target limit and increased its purchase of commercial paper and corporate bonds. The Bank of England has restarted quantitative easing and is expected to double its balance sheet holdings by the year end. The Bank of Canada has launched QE for the first time. The Reserve Bank of Australia has joined the Bank of Japan in attempting yield curve control.
The big picture B of A analysts are saying they expect total holdings of the big six central banks to increase from 46% of GDP at the end of 2019 to around 78% by the end of 2020. And just as a refresher, in 2007 that total was actually 16% of GDP. What do you think about all this firepower?
ROGER HIRST: This whole scenario has been so rapid, and it's unfolding from the collapsing economies and also the response from central banks. And this is something that we've not dealt with before. We've seen collapses in economies before.
And although often we don't see the collapse coming, the 2008 collapse was two, maybe two and a half years in the making. We all-- a lot of people saw the bubble in 2000. And it really took three years to unwind.
This is-- some people say that the underlying fragility was always there, but it's come out of the blue. And it has been such a dramatic collapse in every major economic data print that you could look at in a way that we've never seen before. But the response has been-- I"m not going to say commensurate. But the response has been very, very large and very, very rapid, as it needed to be.
But the big question still remains is over the longer term, are they doing enough compared to the damage being done to the framework? And I don't think they are, but these are huge responses from pretty much every major kind of G7 central bank.
ED HARRISON: Well, you talked about the major central banks. Interestingly, I saw earlier today that Norges Bank, that's the Central Bank for Norway, that they went to zero. This is the lowest rate they've ever had. They were also intervening in currency markets at the same time, which I thought was interesting, because their currency appreciated relative to the US dollar and to the euro.
What do you make of that? Are there any implications, given they're not one of those major banks?
ROGER HIRST: Well, cutting from 25 basis points to zero, bond or flapping in the wind, horse bolted. And I would also say that when you look at interest rates, the Fed cut rates in '00 to '03, in '07 to '08, '09. Cutting rates, I don't think is what's needed in this sort of environment.
It helps on the margin. But actually we've seen that asset prices have often-- at least over the last 20 years, have fallen with rate cuts from central banks. What we clearly needed this time round was this combination of monetary and fiscal, which we've not seen before. I think that's the big game that's in play, so they needed to cut.
Intervening in the currency market, is that a good idea? It doesn't normally work, but obviously they're getting a massive hit because of the oil price. It's a problem for them, as we know, and for the sovereign wealth fund's taken a big hit as well.
I think that the-- I think currencies in this sort of environment ultimately always end up finding the right path. if you do it on your own, you're fighting a massive tsunami. And so I think, therefore, it might have a limited impact to the upside on the Norwegian krone. But if we're thinking about this being a long lasting slowdown and a long lasting outage for oil, then I would still bet on the Norwegian krone versus the dollar going lower.
ED HARRISON: You know, let me go to Europe for a second here, and in particular because you told me that you touched on the ECB yesterday. And one of the things is the size of the balance sheet from my perspective. That's what I was talking to you about earlier,
16% 2007 to 46% right before this, and then we're now moving up to 78%. What do you make of the-- what's the importance of the size of the balance sheet in terms of how it's going to move asset prices?
ROGER HIRST: Well, I think the one people look at the most is currencies. And people look at this huge move in the Fed where they've effectively added $2.5 trillion to the $6.66 trillion as we're recording. We'll get the new numbers out later, and it'll be bigger again.
And it's much, much bigger and much, much faster than a lot of other central banks. So people, therefore, assume from that that the dollar should be weaker because the Fed is being more aggressive. But it's sort of true, but also when you take the Fed's balance sheet as a percent of GDP, it lags the ECB.
And certainly everybody lags the Bank of Japan, which is over 100% now. And also, again, this is sort of a general way of looking at it, but if you look at the balance sheet compared to volumes of currency transacted on a daily basis, the Fed lags almost everybody else. Because the volume of dollars that goes through global markets is so much bigger than any other currency.
So the Fed has been super, super sized in terms of the absolute number. But some of these relative numbers are less so. And I think this is why it's not such a clear, fast story for the dollar and the central bank balance sheet released to the Fed's balance sheet.
Because the relative story the Fed's balance sheet is one which is actually not that amazing versus all the others. So I think that's the key thing is we're looking at currencies and balance sheets ultimately. And then secondly it's the sort of inflation story. But I think that's the story for a couple of years down the road.
ED HARRISON: One of the banks that we haven't mentioned at all, and you've mentioned them in the past, is China. The Chinese Central bank, the People's Bank of China. You've been saying to me for some time now has not participated in this in the way that they had in the past.
What do you think that means for China? But also what does it mean in terms of the threat that they have implicitly toward US government bond assets?
ROGER HIRST: Well, I think the first thing is that they don't want to juice the market in the way that they have in the past. Because in 2009, they did what was a very substantial rate of change of balance sheet expansion. Very-- it was phenomenal back then. And it really did help kickstart that commodity rebound that we saw.
And then in 2016, after the Shanghai or during the Shanghai court, they were, again, doing a very significant rate of change of balance sheet in terms of-- they call it total social financing. Now the size of total social financing has actually reached a new record if you take the last two months added together. But it's diminishing compared to overall GDP. And obviously, we had a drop in GDP.
But I think China's just a little bit nervous about-- they've got this-- the number of issues they have to deal with, which is they want to obviously support the market. But they also don't want to create too much of an inflationary bottleneck, and right now they could create an internal inflationary bottleneck. Even though getting back to some form of productive capacity they're creating a lot of goods, but those goods are for foreign entities where demand is not there yet.
So that's deflationary for other countries, not themselves. So I think they've been a little bit reticent to go down that path.
Now in terms of their treasuries, people are saying recently, oh, they're weaponizing, or they could weaponize the treasuries. In fact, they've said, well, we'll sell them. I'm not that bothered about that, because they've got 1.1 trillion.
But we've seen 2.4 trillion added to the Fed's balance sheets in the last six weeks, and we could go to 10 trillion at the end of the year. We might have 4 trillion of new issuance this year, so OK. New issuance plus China is more than they will add between now and the end of the year.
But that's new issuance, not net new issuance. But the Fed can buy it all if they want to. So to me, it's not really a problem.
I think if China needs dollars and they want to sell out, well, the Fed put swap lines in place and repo facilities in place for most countries to be able to get hold of dollars. China needs to do that, fair enough. I do think that the Chinese need to devalue, because they need to export their way out of this rather than pump money into it.
ED HARRISON: Yeah. I mean, that last point about the devaluation, that's the thing I was thinking the whole time is that to the degree that they're going to sell any treasuries, it's going to have a currency effect. I mean, obviously if they're going to have the balance that they have with the United States, they're going to be accumulating dollars. They need to hold those dollars in some asset form.
And so they've decided that they would do treasuries. But if they change their currency then it'll be a different story. If they devalue their currency, it would suggest to me that they would actually need to have more. They would have to buy more US treasuries. Doesn't that make sense?
ROGER HIRST: Well, I think there's the whole game that they're playing at the moment, which-- there's the whole game that people think that they're playing at the moment, which is that they're going to use this balance in order to maybe tweak the dollar, maybe attack the US. And I just don't think that's really particularly probable on all counts.
Because one thing that the US really does want is that they'd like to see the dollar weaker in the short term. Because a weaker dollar would help a lot of the emerging markets, the emerging markets like Brazil, which have been suffering from strength in the dollar weakness in their own currencies. So I think that it's not in anyone's interest to weaponize the treasury market and to try and to deal with currencies in this way.
China does need to devalue, but it needs to do it gradually so as not to upset anybody. Because it's going to have an inventory overhang soon the way it's starting to produce once more. But I think overall when I look at these various balances between the bigger countries, and obviously China is the one that stands out, and Russia as well. But I think it wouldn't benefit anybody to start doing a rapid sale.
And if you tell everyone you're doing a rapid sell, then everyone's going to front run you anyway. So there's no point in doing that. Which is what everyone's done to the Fed, and the Fed's not bought anything yet. And that's the game that's in hand at the moment.
ED HARRISON: Right. That is interesting that that's how it is. They haven't bought, but yet all they need to do is just say that they're going to buy and the market moves to-- I mean, basically that's what happens with the Fed funds rate to begin with. They don't need to actually do anything in that market for the market to move there.
ROGER HIRST: No. And it's [INAUDIBLE] like Draghi used to do. We'll do whatever it takes.
Well, the Fed's done a very good job so far. And I think in some ways what would be a little bit nervous-- makes me a little bit nervous is that, no, they haven't been buying. I don't really want to see them buying now that everybody's front run them, but they will probably have to. Otherwise, people might start to get a little bit nervous.
But what it also has done is it sucked in a lot of retail, and we've seen this when you look at the Robinhood accounts. You can see it in oil. You can see it in this ETF called jets, which is airlines. You can see in a lot of areas [INAUDIBLE] day trading margin accounts has been the big explosion.
Prior to this year, retail and that emotion, that whole-- what you want to see in a bubble is emotion, particularly from retail. That has been particularly absent. But it looks like where they can retail who have dry powder have been coming into this market and buying the dips.
So I think they've been one of the drivers to the upside, along with a slight re-leveraging of some of the risk parity type funds. Plus also those quasi banks, which are really hedge funds who've been getting the cheap repo money and putting that into the market. And that's been driving this up in the volumes, which are much, much lower which I mentioned last week and yesterday.
ED HARRISON: I want to go back to something that you were talking to Ash about. That is, Europe, in terms of the German constitutional court and the implications there for the eurozone.
I don't look at them as particularly positive. And I know that you guys were talking about it. What's your overall view of what the importance is?
ROGER HIRST: Well, actually, I'm interested to hear your views. I think you've obviously been in Germany and you've looked at it more closely. Because I have to admit that I've tended not to look at the details.
Because whenever I've seen this before, there's always been a fudge, which is what I mentioned yesterday. I.e. the worst case scenario is always avoided because the worst case scenario would be bad. But I'd love to hear what your take on it is, because clearly there is some friction there. There always is.
But do you think this is friction, which is actually going to bubble to the surface during this crisis? Will it be postponed till after the crisis?
ED HARRISON: Yeah. I mean, that is a good question, actually, whether they can fudge it now. But I think that the second part of your question about after the crisis makes a lot of sense to me. I mean, the framework that I'm looking at, let's go backwards from the future to today and we can take a look at that.
In the future at a minimum, what's going to happen is that you're going to leave the crisis with the indebtedness in Italy and in Greece at astronomical levels. The only other countries that would be higher is Japan, basically. And so the question then is, is what do you do about that?
Because Italy will be at 160% debt to GDP. Greece will be at 180%, 200%. There's going to be an absolute dearth of impetus for people to go there.
No one's going to go there for vacation. Greece is very dependent on tourism, so they're going to have to be running deficits. They don't want to be engaged in austerity, so you have a problem there.
The only way that you can really solve that problem is through corona bonds or eurobonds without having a default. So ultimately what that means is that you have to have debt mutualization, or Greece is going to have to default and perhaps the same thing is true for Italy. And what this German constitutional court decision says basically is that if you want to engage in quantitative easing, you ECB, we need to have a change in our treaty.
We need to have a change in the German [SPEAKING GERMAN]. Either of those two, if they don't happen, then you can't do it. It's illegal.
So if you can't do it for quantitative easing, you're definitely not going to be able to